DXC Technology Company (DXC) — Q4 2016 Earnings Call Transcript

Thank you very much, and good afternoon everyone. I'm pleased you've joined us for CSC's fourth quarter 2016 earnings call and webcast. Our speakers on today's call will be Mike Lawrie, our Chairman and Chief Executive Officer; and Paul Saleh, our Chief Financial Officer. As usual, the call is being webcast at csc.com/investor_relations and we've posted some slides to our website which will accompany our discussion today. Please note that we will be filing our 10-K for fiscal 2016 early next week. On the slides, on slide two, you'll see that certain comments we make on the call will be forward-looking. These statements are subject to known and unknown risks and uncertainties which could cause actual results to differ materially from those expressed on the call. A discussion of risks and uncertainties is included in our Form 10-K, Form 10-Q and other SEC filings. Slide 3 informs our participants that CSC's presentation includes certain non-GAAP financial measures and certain further adjustments to these measures, which we believe provide useful information to our investors. In accordance with SEC rules, we've provided a reconciliation of these measures to their respective and most directly comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release, as well as in our supplemental slides. Both documents are available on the Investor Relations section of our website. CSC will file with the SEC a proxy statement on Schedule 14A, and a registration statement on Form S-4 containing a prospectus. Investors and security holders are advised to read the registration statement and prospectuses and the proxy statement when they become available because they will contain important information about the parties and the proposed transaction. Many factors could cause actual results to differ materially from such forward looking statements with respect to the announced transaction, including risks relating to the completion of the transaction on anticipated timing, including obtaining shareholder and regulatory approvals, anticipated tax treatment, unforeseen liabilities, future capital expenditures, inability to achieve expected synergies, loss of revenues, delay or business disruption caused by difficulties in integrating the businesses of CSC and Enterprise Services. Finally, I would like to remind our listeners that CSC assumes no obligation to update the information presented on the call, except, of course, as required by law. And now, I would like to introduce CSC's Chairman and CEO, Mike Lawrie. Mike?

Thank you, Neil. We have a lot happening today. I want to begin with a brief overview of the transaction, then discuss our fourth quarter and full year earnings, before handing it over to Paul for more details on the earnings announcement. As you saw earlier, we announced our intention to merge CSC with the Enterprise Services segment of Hewlett Packard Enterprise, and both boards have unanimously approved this merger plan. This merger will result in the largest pure-play IT services company globally, generating $26 billion in revenue with exceptional capabilities and global reach. I will also explain why we are pursuing this now. Merging CSC with HPE's Enterprise Services marks a crucial step in the transformation journeys of both companies. The merger will create an agile and flexible global technology services firm that is well-positioned to lead our clients through digital transformations amidst rapidly evolving business needs and customer expectations. Regarding the details, CSC and HPE shareholders will each hold about 50% of the combined company. The merger is structured to be tax-free for both CSC and HPE shareholders. The newly formed entity will take on around $2.4 billion in expected debt, pension deficits, and other liabilities from HPE and receive a $1.5 billion cash dividend related to the spin-off of HPE's Enterprise Services division. I will take on the role of Chairman, President, and CEO of the combined company, concentrating on achieving $1 billion in cost synergies in the first year, with a run rate of $1.5 billion at the end of year one and the possibility for further synergies over the next two to three years. We focused on creating value for four main stakeholder groups: our clients, employees, alliance partners, and shareholders, and we believe this merger will significantly benefit all of them. In terms of next steps, merger and integration planning is already in progress, led by dedicated teams from CSC and HPE. For our stakeholders, it will be business as usual, as we continue to provide excellent client service and keep everyone informed as we approach key milestones. To elaborate further, merging CSC with HPE's Enterprise Services will create a $26 billion independent global IT services leader. CSC is valued at $8 billion, with global strengths in insurance, healthcare, and financial services, while HPE's Enterprise Services is an $18 billion IT solutions company with leadership in transportation, pharmaceuticals, technology, media, and telecom. Together, we will become one of the world's largest pure-play IT services firms, positioned to drive digital transformations for clients through world-class offerings in cloud services, application modernization, business process services, security, and mobility. The merger is expected to generate around $1 billion in synergies within the first year post-closing, with a run rate of $1.5 billion by the end of year one, and we foresee opportunities for additional synergies in subsequent years. As joint shareholders, CSC and HPE shareholders will benefit from the combined company's synergies and future earnings growth. The timing of this announcement reflects the ongoing multi-year transformations of both CSC and HPE. Over the years, both companies have worked diligently to revise their operational models, labor mixes, skills, and financial profiles to better position themselves for profitable growth. Upon arriving at CSC four years ago, our management inherited a fragmented operating model with low profitability due to unsustainable cost structures and an outdated strategy. We have successfully executed many turnaround plans, restoring CSC to health and profitability. HPE is on a similar path and has made significant progress, as discussed in their earnings call earlier today. Both companies recently spun off divisions to sharpen their focus on client needs. This merger represents an extension of the strategies initiated by our spin-offs and builds on the substantial progress made by both companies so far. Let’s now consider the advantages of this merger. First, there’s the increased scale: combined, we’ll have $26 billion in revenue and more than 5,000 customers, placing us among the largest IT services firms worldwide. Second, we possess complementary industry leadership: CSC has expertise in insurance, healthcare, and financial services, while HPE excels in pharmaceuticals, transportation, and telecommunications. Additionally, we will have a $3 billion portfolio of next-generation business offerings. Third, we have a clearly defined and actionable cost synergy roadmap. As you may know, CSC executed a $1.9 billion cost reduction initiative over the past few years, culminating in the spin-off of our CSRA division. We believe a similar opportunity exists for the efficiencies that Meg and her team at HPE Enterprise Services have initiated. Fourth, our combined entity will have the financial foundation to invest in next-generation solutions while maintaining strong free cash flow and an investment-grade capital structure. Fifth, our leadership team from both CSC and HPE Enterprise Services has a proven track record of successfully transforming businesses, which bodes well for our goals. Now, regarding our operations, the merged entity will run around 85 delivery centers and 95 data centers across over 70 countries, serving 5,000 clients. 50% of our workforce will be located in low-cost regions, and importantly, there is minimal existing overlap between client bases. Out of our top 200 accounts, there is less than a 15% overlap in revenue streams. The combined company will lead major industries and offer over $3 billion in next-generation solutions, with a balanced focus on global business services and global infrastructure. Furthermore, this merger strengthens our vital partnerships crucial for executing our business model. Now, about the transaction: each of CSC and HPE shareholders will hold about 50% of the new combined company, sharing in future synergies and operational success. We aim to ensure the new entity has a capital structure in line with an investment-grade credit profile, with plans for closing the transaction by March 2017, pending regulatory approvals. We're also establishing the governance and leadership framework for both companies. I will serve as Chairman, President, and CEO of the new organization, with Meg Whitman on the board. The board appointments will be split evenly between directors nominated by CSC and HPE. Paul Saleh, CSC’s CFO, will continue in his role post-transaction, and Mike Nefkens from HPE’s Enterprise Services will be instrumental in our leadership team. Further appointments will be announced later. In pursuing this merger, we firmly believe in the substantial benefits for our stakeholders. For our clients, this new company aims to facilitate their digital transformations, offering technology independence and access to top-tier solutions spanning cloud, mobility, application development, business process services, big data and analytics, IT services, workplace solutions, and security. For employees, it will remain business as usual initially, but we anticipate significantly enhanced career development and expansion opportunities in the new organization. This represents a significant leap in our transformation, empowering our workforce to innovate and adapt to the evolving market landscape. Our strategic partners will also benefit from enhanced capabilities through our new company’s scale and competitive edge. Lastly, investors will see opportunities for substantial value creation from owning a new company with an exceptional operational and financial profile. The combined entity will possess the necessary scale, innovation, and financial resources to achieve and maintain market leadership, with a tax-free transaction designed for significant value capture from synergy potential. To conclude, this overview encapsulates a transformative phase for CSC and HPE. Our merger and integration planning is underway while ensuring business continuity for stakeholders, as we aim to maintain excellent client service during the pre-closing period. I believe today marks an exciting step forward in bringing together two outstanding companies, establishing a new company equipped for ongoing transformation, value creation, and superior service delivery for our customers. Now, I will proceed to discuss our earnings. Our fourth quarter non-GAAP EPS from continuing operations was $0.73, while for fiscal 2016, it was $2.52. In the fourth quarter, our commercial operating margin stood at 8.6%, and for the fiscal year, it was 9.3%. Revenue for the fourth quarter increased by 3% sequentially but saw a decline of about 2% year-over-year in constant currency. Our reinvestment in offerings has resulted in positive momentum across business units, as indicated by a book-to-bill ratio of 1.3x for the quarter. We're making strides toward revenue crossover, achieving over 60% year-over-year growth in next-generation offerings during the fourth quarter. Additionally, next-generation bookings remained strong, with a book-to-bill ratio of 2.8x. For fiscal 2016, next-generation revenue increased by over 54% year-over-year. The acquisitions of UXC and Xchanging have significantly advanced our strategy as we enter fiscal 2017, presenting further cost synergy opportunities in the latter half of the fiscal year. For fiscal 2017, we aim for revenue growth in the low double digits on a constant currency basis, reflecting contributions from our UXC and Xchanging acquisitions. Our target for non-GAAP EPS from continuing operations is $2.75 to $3 per share, excluding amortization of all purchase accounting intangibles, aiming for free cash flow of at least 100% of net income. I will now provide additional details on these points and then hand over to Paul for further insights on our fourth quarter and 2017 plan.

Thank you, Mike and good evening everyone. Before I review the fourth quarter and the full year, let me cover some items that are included in our GAAP results. First, in this quarter we had $78 million in pre-tax expenses or $0.51 per diluted share. Those are related to separation, restructuring and other transaction activities. Second, we had a non-cash pre-tax charge of $118 million or $0.84 per diluted share, and that was related to our annual re-measurement of pension plan assets and liabilities. Third, we had a pre-tax charge of $100 million or $0.46 per diluted share associated with the retirement of our 6.5% coupon 2018 bonds. Lastly, we had a $14 million or $0.10 per diluted share benefit from the adoption of a newly accounting standard for stock-based compensation which was offset by an adjustment to our tax valuation allowances. Now these items have been excluded from our non-GAAP results for the quarter and the full year. Now let me turn to our fourth quarter and full year results. Fourth quarter revenue was $1.8 billion, down 2.4% year-over-year in constant currency, and on a sequential basis fourth quarter revenue grew 3.3%. Sequential growth was driven by higher revenue in BPS and consulting within our GBS segment and our GIS business was also up slightly sequentially. Commercial operating income adjusted for separation, restructuring, and other transaction costs was $156 million in the quarter. Commercial operating margin on that basis was 8.6%, down 260 basis points from the prior year, reflecting our continued investment in next generation offerings. In addition, the UXC acquisition was a headwind of 30 to 35 basis points to our margin due to the accounting effect of moving UXC from IFRS to US GAAP. Earnings before interest and taxes adjusted for special items was $123 million and EBIT margin on that basis was 6.8%, down 110 basis points from a year ago. Our non-GAAP diluted EPS from continuing operation was $0.73, up from a year ago. Now in the quarter, our effective tax rate was 5.5% reflecting the benefit of our global mix of income on a full year basis. Bookings in the quarter were $2.3 billion and overall our book-to-bill was 1.3 times. For the full year revenue was $7.1 billion, down 6.7% in constant currency. Commercial operating income adjusted for separation, restructuring, and other transaction costs, was $660 million and adjusted commercial operating margin was 9.3% for the year which was flat with the prior year. Non-GAAP EPS from continuing operation was $2.52 for the year, which is up 12% from the prior year. Turning now to our segment results. Global business service revenue was $941 million in the fourth quarter, down 1% year-over-year in constant currency and up 6% sequentially. Adjusted operating income for GBS was $104 million in the quarter. Our operating margin on that basis was 11.1% compared with 16.3% in the prior year and that reflected the investment in our business process services platform and investment in our new banking JV with HCL. In addition, our margin reflected the impact of lower profitability in our consulting business and the headwind of 60 basis points from the UXC acquisition. Our GBS bookings were $1.1 billion in the quarter for a book-to-bill of 1.2 times. And for the full year, GBS revenue was $3.6 billion, operating margin was 11.6%, and bookings were $4.3 billion. Now turning to the Global Infrastructure Services business. Revenue was $866 million in the quarter, down 3.7% year-over-year in constant currency. Now we're seeing the moderation of the decline of our traditional GIS business which was partially offset by strong next-generation growth in cloud and MyWorkStyle. Adjusted GIS operating income was $52 million in the quarter and our operating margin was 6%, up slightly year-over-year. Bookings for GIS were $1.2 billion in the quarter for a book-to-bill of 1.4 times. And for the full year GIS revenue was $3.5 billion, adjusted operating margin was 6.8% and bookings were $4.3 billion. Now for the year our free cash flow was $319 million. Our free cash flow was approximately $66 million negative in the quarter but that was reflecting a delay in billings attributable to our migration to a new financial system in the Americas. For the full year CapEx was $591 million and CapEx in the quarter was $169 million. For the full year, CSC returned $603 million of capital to our shareholders, $430 million came from dividends, of which $117 million were ordinary dividends and $313 million was a special dividend associated with the separation of CSRA. And for the full year, the company repurchased $173 million in shares. During the fourth quarter, CSC returned $65 million to shareholders consisting of $20 million in dividends and $45 million in repurchases. And cash on hand at the end of the quarter was $1.2 billion and our net debt to capital ratio was 31.3% at the end of the year. So in closing, let me review our financial targets for fiscal '17. We’re targeting revenue to be up in the low double digits in constant currency. We're targeting non-GAAP EPS from continuing operations attributable to the parent of $2.75 to $3 and we expect stronger earnings in the second half of the year as synergies related to the UXC and Xchanging acquisitions are realized. And our EPS target assumes a tax rate of approximately 20% for the full year. Our free cash flow target for fiscal '17 is 100% or more of net income. And now I will hand the call back to the operator for the Q&A session.

Thanks guys. Congratulations on the deal. Pretty interesting. Wanted to just get your initial view on what your year-one accretion can look like from HPE, inclusive of at least the initial $1 billion of cost synergies.

I think we'll give you those kind of numbers a little bit later. We’re just really right now just pointing you to the synergies of $1 billion in the year and $1.5 billion on exiting that first year, and the HPE services group will be providing their guidance for the full year.

I think what we'll do as we get closer to the actual close, we’ll obviously do another investor day and analyst day, so we can share what this all looks like as we put it together and get committed to the execution.

And then if we look at those cost synergy numbers, I mean our preliminary math is you're looking at a combined overall cost base here of somewhere in the neighborhood of $24 billion or so when you bring the companies together. So even at the $1.5 billion number, I think you'd be looking at about 6% or so. It sounds like you're very confident in the $1.5 billion, so could there be some upside here and once you get further along with the integration efforts?

Yes, I think listen, we're very comfortable with the $1.5 billion. We've identified that, it's spread across a number of areas harmonizing policies. We've talked about 95 data centers and delivery centers, obviously that can continue to be consolidated. There is a significant, we think, improvement capability because of the increased scale that we’ll have now on a global basis. We're about 50% right-shoring, so there is some opportunity there. So yeah, there's a significant opportunity. You are right, the $24 billion cost basis, there's probably room to grow that as well over time.

And then just lastly on the fiscal ’17 guidance, can you clarify how much accretion, if any, is in the non-GAAP EPS from UXC and Xchanging, in other words, excluding intangibles and then are you assuming a crossover point to positive constant currency organic growth before the end of the fiscal year?

From the GAAP that we talked about at the Investor Day, we saw a continued improvement in the fourth quarter on that GAAP. With these acquisitions now. I mean, that crossover point will be achieved in the first quarter of this year. So with the full quarter of UXC and then Xchanging, that crossover point will now occur in the first quarter. If you go back on just a pure organic basis, yeah, I think that that GAAP is going to cross over roughly when we talked about, but probably we're not going to talk about it that way if I talk about it more now in total of our next generation offerings versus the decline in the traditional business, but even this quarter, you saw – you continue to see the flattening out of that decline. We've seen that now for two or three quarters, that continued in the fourth quarter and the continued ramp-up of the next generation revenue streams and the highlight there of some of the key wins was very important for us in the fourth quarter.

Hi, good evening. I was curious, the legacy EDS had a lot of federal government business and you just spun off your CSRA. Is there a piece of revenue here that you're going to have to spend, because I believe you're committed not to compete in the U.S. federal space?

The transaction is structured in a way that gives us several options regarding that business. We have always appreciated this business, which is why we previously spun off CSRA and merged the CSC NPS business with SRA last year. HP Enterprise Services has a strong position in the federal government sector. After the transaction is complete, we will consider all options moving forward. However, the decision will be made after we finalize the transaction.

Obviously great book-to-bill again, how much of that is incremental business and how much of that is recompete?

I don't know whether I have the exact numbers, Paul, if I remember correctly, I think somewhere around 50% of that was new business and 50% of that was recompete business. This quarter was a little stronger on new. That’s why I want to be a little careful on the number because I just don't have it in front of me, but the Metropolitan Police, for example, was a completely new incremental win for us. Most of the new logo business that I talked about was also new business. Paul, do you have any detail on that?

No, Mike, I think –

About 50% was incremental new business, and the rest was recompete or extensions of existing contracts.

Thank you. So Mike, I think I understand the scale on the cost synergies and the benefits of the merger. But I guess I'm still trying to get my arms around some of the strategic benefits and perhaps my knowledge of HP’s service business is somewhat dated. But if I recall, they didn't have a particularly strong professional services organization, and I'm just trying to get a better feeling in terms of how the market is shifting and how their native capabilities that they bring to your portfolio, how that really enhances kind of your strategic position in the marketplace?

That’s a great question. First and foremost, as I said it brings scale. That's very important. They have made a fair amount of progress over the last two years in terms of dealing with their headwinds. They had many of the same headwinds that we had, traditional clients either moving away from them or contracts that were in a wind-down phase and mode that caused them a significant revenue headwind. They too are seeing those revenue headwinds abate. They have a strong cloud business, they've got a strong cyber business, they have got a strong big data and analytics business. They've got a good applications business. So they too have made investments in some of these new offerings and that too is offsetting the headwinds in their traditional business. The thing that was amazing to me when we went through all of this is the very little overlap of the top 200 clients there's less than a 15% overlap. So that gives us an opportunity to expand our footprint in their customer base and for them to expand their footprint in our customer base. We have agreed to a partnership agreement with HPE. So we will have access to their solutions across their networking and their storage and their server and their software businesses which will also give us the opportunity to expand the profile. So global scale is one, reach, lack of overlap, a very solid skill base. This gives us a critical mass now of skills in new areas like cloud, cyber, the other business areas that I just mentioned to you. And I think most importantly for us, as we see more and more clients making a more dramatic shift to this next-generation cloud infrastructure and the modernization and deployment of new applications, that takes scale and it takes financial commitment. And this combination gives us a balance sheet and a financial structure that will allow us to really help major clients around the world make that transformation to the digital world.

In that context about the balance sheet, could you explain what it looks like after the close of the Xchanging deal, since that likely wasn’t reflected in the March 31 numbers? Additionally, you mentioned an increase of about $2.5 billion in debt, along with another $1.5 billion payment to them. What should we understand about the current balance sheet in terms of leverage and how much we need to add after this transaction closes?

So I think what you think about this, if you add the two companies together on a pro forma basis you would have about $7.5 billion in maybe gross debt and net debt of about, maybe $5.5 billion or so in net debt. And the ratios will be very consistent, as Mike has indicated, with an investment-grade profile.

And that net debt includes the pension, Paul?

No, the net debt is just the cash position that we would have on the balance sheet. Right now it's about $1 billion, I think probably by the time of the close, it would be somewhat closer to $2 billion of cash on the balance sheet. And most of the capital structure will be very flexible.

Right, but does the debt number include the pension liability for both companies?

No, it does not. I think it will be minimal on both sides, and it would be probably less than $1 billion for both.

Right. And then how much was the incremental leverage to close Xchanging then, or what does that do with the balance, since that was after – just so we know where you are right now?

I believe it will result in an additional $500 million to $600 million in debt. We had already acquired 10% of the stock before finalizing the transaction.

I got it. And just one last one, what is your FX assumption for this year in your guidance?

Right now we are assuming flat. We don't know exactly what the dollar is going to be doing.

Okay. So the report on a constant currency would be about the same.

Hi gentlemen, thanks very much. Mike, I wanted to go back to the cost savings. Originally when EDS was bought, Mark Hurd spent a lot of time taking costs out mix, and spent the last five plus years taking incremental costs out, you've obviously been very aggressive with CSC. So when you talk about $1.5 billion, on what would be pro forma revenues of $25 billion or $26 billion, that's almost 6%. So are you talking about taking incremental costs out, or is this really duplication of overlapping resources?

It's a little of both. There is clearly a duplication, I mentioned a couple of areas like the data centers and delivery centers. There's absolutely no question about that. I think there'll be obviously some synergies that we can get across the sales forces, delivery organizations. So the other area is real estate. Real estate, we think, is going to be a significant area of consolidation. And then as I mentioned, procurement, this will allow us to do much more from a global procurement standpoint, the support functions, all of those things are built into that synergy roadmap. And these synergies by the way don't come all from HPE Enterprise Services. This really is across both organizations.

If I could just ask one, a bit more on Xchanging and UXC, how much was the revenue in the quarter, you got a little bit of help – but you mentioned the cost synergies that you think you get from this I think $25 million to $50 million or $40 million, what do you –

$25 million to $45 million will mainly be realized in the second half of fiscal 2017. The reason for this timeline is that we are implementing measures in Europe, which require more time, and similarly, the synergies from UXC will be fully realized in the second half of the year. Looking back at the synergies, we have significantly reduced costs at CSC over the past few years. In some instances, we will even invest in our operations. Certain support functions will gain access to new skills and capabilities, enabling us to invest more. For example, we have made investments in our financial systems, and we will continue to do so with some of our HR systems and our customer-facing sales force system. Thus, our strategy is not solely focused on cost reduction; we also see opportunities to reinvest in our personnel and crucial functions, as we now operate at a greater scale.

Right. Well, that's a great point, because a lot of times when HP was taking costs out they would reinvest. So if you have a $1.5 billion that you earmarked as potential cost savings, is there a amount that you think about that investors at least notionally would see on the bottom line? In other words, would you drop half of that at the bottom line, or 75%, or is there any kind of guidepost that you can identify how investors should be thinking about that?

I don't have a specific benchmark for that. As I mentioned, we've identified the net synergies and the areas where we believe we should reinvest in our business. Overall, we feel confident about achieving $1 billion in the first year, and a run rate of $1.5 billion by the end of our first full year of operations. We will be investing in our workforce and enhancing our skills while continuing to enhance our product offerings. We've made a significant investment in these offerings, which are beginning to yield positive results. We are starting to secure notable business thanks to these offerings. This has been a long-term effort over the past two to three years, but it is now starting to deliver returns with these book-to-bills and major new wins. The advantage of this growth is that it enables us to reach a higher scale, providing us more flexibility for these investments while also achieving considerable cost synergies, much of which can be redirected to shareholders through improved operating performance.

I want to expand on what Mike mentioned because the synergies are extremely important. We have dedicated considerable time with both teams, identifying over 20 categories of synergy opportunities. We carefully examined each one to fully understand them. We aimed to maximize these opportunities, ensuring we were confident in our commitment to achieve the billion dollars in annual synergies and a run rate of $1.5 billion. We've reviewed our cost structure and the benefits of scaling. It's important to note that some synergies won't come solely from eliminating real estate or leveraging procurement scale. As Mike pointed out, aligning our standards and policies across both companies will also generate synergies. Each company excels in different areas, and by combining our strengths, we'll see synergies from realigning similar practices and accelerating cost reductions we were pursuing separately. Together, we will reach our goals more quickly.

And let's plan on two last questions, operator.

Yeah, hi, just a couple clarification questions. I guess, first in the quarter how much acquisition revenue was in the quarter and was it equally split between GBS and GIS?

About $30 million to $40 million.

$30 million to $40 million?

Yes.

Was it just in GBS or was it also in GIS?

No, I think it was actually primarily in the GBS business, a little bit in GIS, maybe about 20% of it.

And then just on the quarter itself, the Street was looking for 9.2% operating margins and you guys did 7.6%, so it was quite a bit lower and you guys had a much lower tax rate than anticipated. Were the investments known or did you guys just take the opportunity with the lower tax rate that you’re going to have to invest going forward?

Yeah, we did. There is a little bit of both. If you look at this, I said probably 30 to 50 basis points, these are rough numbers, I would associate with the fact that we integrate the UXC at basically a zero margin. We did make some investments, the most notable one we’ve been making for the last quarter or so but we increased that was in our BPS platform. Because we are expecting to grow that business pretty significantly, and that does require an investment in the platform and in the people and in some of the skills that we have supporting that business. And then we continue to make an investment in some of the offerings, I mentioned a couple, MyWorkStyle, what we're continuing to do in our cloud business. And then as we have begun to transition some of our clients from a more traditional infrastructure to a hybrid cloud structure, there are some upfront costs that we incur in that transition that we will recoup as we go through the year. So we expect some of these trends to definitely persist through the first half of our new fiscal year. So those were the primary drivers of the 180, 200 basis point lower margin, and they were spread pretty equally across, as I said, UXC, the investment in our BPS platform and our reinvestment in the offerings. The other thing I would say is that we moved a little slower than what in all candor I had anticipated in some of our cost takeout activities, primarily in Europe.

Yeah and you mentioned some lower profitability in some contracts too within the quarter?

No, it wasn't lower profitability. It was the transition of some of our clients from our more traditional offerings to our next generation offerings.

The lower profitability I was referring to was in the consulting business. If you look at it on a year-over-year basis we saw, just because of the repositioning that we've been making in that business, the profitability was lower on a year-over-year basis even though the revenue was –

The revenue was beginning to come back in that business.

And then just on the guidance, just so we have it, just thoughts on constant currency without the acquisitions for the two segments and then tax rate and operating margin.

I think we said actually for the combined entity we were going to be going up low double digits on constant currency. The contribution from those acquisitions, again as Mike mentioned, they're going to be more integrated within our business but the assumptions that we're making is that they'll add about $1 billion of top line revenue. And in terms of the tax rate, I mentioned it in my comment it will be about 20% for the full year.

Okay. Last one for me then just on the acquisition. If I look at Enterprise Services, it looks like they did about $19.8 billion in revenue but you guys are talking about $18 billion in revenue. So just trying to reconcile what they did last year versus what you guys will pull forward, will there be some divestitures or is that just natural drop off of some of the –

No, I think they're keeping two businesses, they are keeping their network services business, the CMS, and also contributing to the lower comparability to what you're describing.

Thanks guys. I'm just trying to understand, when I look at the growth inflection you said organically, I think you mentioned before the first quarter you’d see go positive obviously with the deals. But again that's just a bit of a follow on to Bryan’s question, that's not pro forma organic growth for, as if you owned the deals last year though, is that correct?

That's absolutely correct.

So that inflection you said is kind of back to where we thought it would be from the Investor Day, so perhaps sometime during fiscal ‘17?

Yes. To be clear, we were facing a gap of several hundred million dollars between the decline in our traditional business and the growth of our next generation offerings. That gap is now below $100 million per quarter and has been narrowing for almost two years as these new offerings are being developed and installed with our customers. The acquisition of UXC and Xchanging has accelerated this crossover point to align with what we discussed at the Investor Day. On an organic basis, we expect the gap to continue to close and likely cross over in the second half of fiscal ’17, but due to these acquisitions, that crossover is now expected in the first quarter of 2017.

That's helpful. When we examine the future revenue mix considering the integration, you mentioned a potential revenue of $26 billion. Previously, in CSC standalone, before these deals, there were about $700 million classified as growth revenues in next-gen solution revenues. Can you provide insight into the expected profile of this revenue mix going forward? I'm asking because HPE's services division experienced a decline last year. I'm trying to understand if we are facing a situation where certain parts of the business need to be eliminated similar to what occurred in legacy CSC, while also recognizing that there's a potential growth inflection coming from parts of the business combined with what you'll have after the integration. How should we perceive the mix of growing business versus what is likely to phase out?

Yeah, I think we think of the profile, we've got a $3 billion plus business in next generation. And that is growing on both our side and on the HPE Enterprise Services side. They've got probably roughly – again these are rough numbers here, about $8 billion, think of it as GBS type business, so application business, mobility, those kinds of offerings in the marketplace. And then the balance is more of the traditional IPO although they too have been transitioning some of their clients to much more of a cloud environment. So the profile of the business, our profile around next generation offerings gets strengthened pretty dramatically with this merger.

The percentage of your total revenue goes up I guess in terms of the profile?

That's exactly right. The growth rates are increasing, and many of the contracts that HPE Enterprise Services had, including those with GM and Bank of America, are now behind them. They have also secured significant new wins over the past year, contributing to their revenue, such as contracts with Deutsche Bank and Nokia. Additionally, we will be incorporating HPE and HPI, which are outsourced contracts that will now be part of the new company’s portfolio. All of this results in a much healthier mix geared towards new and growing segments. The critical mass we have achieved allows us to recruit and retain talent for these platforms more effectively. In summary, we have reached critical mass in these important emerging segments.

So last question, when we consider the pro forma entity even a year after the deal closes, it might be premature to ask, but is it a story of organic growth, specifically anything above zero percent that I'm trying to understand?

I believe we won't face significant revenue dis-synergies due to minimal overlap, as I mentioned earlier. I need to conduct more analysis before I can confirm whether we are looking at 2% growth, 3% growth, or something else. This will be part of our efforts over the next few months as we form our integration teams, and we will have more clarity as we approach the closing of the transaction. The main focus for short-term value creation is the synergies; opportunities like this are rare. It reminds me of the situation CSC found itself in three or four years ago, representing a valuable opportunity. Ultimately, this development elevates CSC or NewCo, whatever we choose to call it, to a new level. It provides us with critical mass, skills, and financial strength to shape our own future. Our previous acquisitions, such as Xchanging, UXC, and ServiceNow, have been great strides, but they were smaller, leading to a slower accumulation of necessary critical mass in new areas to balance out the decline of our traditional business. This enables us to achieve the scale needed to compete effectively in the market, which is very exciting. In the past, I emphasized the need to get fit, improve performance, and then assume a leadership role. This positions our commercial business as a global leader, similar to how the spinoff and merger between NPS and SRA established a leader in the federal government IT sector. Overall, this initiative is about fostering a leadership position, building a new foundation, and starting fresh.

Okay. Makes sense. Congrats guys, thanks.

Thank you everyone for being on the call. We will talk to everyone next quarter. Thank you.